Wednesday, February 13, 2008

Carbon Tax vs Cap-and-Trade

A tax could achieve a long-term emission reduction target at a much smaller economic cost than an inflexible cap.

Provided that the tax was set equal to the expected benefit of reducing a ton of CO2, a tax could thus result in substantially greater net benefits (benefits minus costs) than a comparable cap-and-trade program.

The advantage of a tax stems from the long-term nature of climate change (which depends on the build-up of emissions over many decades, but is not sensitive to the amount of emissions in any given year) and the uncertain and variable nature of the cost of reducing emissions (which will vary from year-to-year based on the weather, conditions in energy markets, and the availability of new technologies).

An inflexible cap-and-trade program would provide more certainty about annual emissions than would a tax; however, that certainty would come at a cost:The cap would require too many reductions when the cost of achieving them was high and would mandate too few reductions when the cost was low.

About Me

I am the Robert M. Beren Professor of Economics at Harvard University, where I teach introductory economics (ec 10). I use this blog to keep in touch with my current and former students. Teachers and students at other schools, as well as others interested in economic issues, are welcome to use this resource.